What is Cryptocurrency Mining?

written by David AmoyalPublish date: 01/21/2018(Last updated: February 28, 2018 01:04 PM)

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Cryptocurrency mining is the process of verifying groups of transactions called blocks and adding them to other blocks to form a blockchain. Once a block is verified, it is added to the decentralized ledger, signifying its status as a confirmed group of transactions.

The mining processes

The mining process starts as collections of transactions from the network are bundled together to form blocks. Miners, either solo or in mining pools, then discover the block and begin the mining process.

These nonces are used to diversify the range of inputs in hash functions, which convert an input of letters and numbers into a corresponding output with a fixed length.

The goal is to use cryptographic functions to propose the hash that satisfies a given arbitrary condition.

Once the condition is met, the block is solved, and the transactions are added to the blockchain.

Popular Mining Protocols

Each cryptocurrency follows a specific mining protocol. There are dozens of different protocols in use, but the two most well known protocols are Proof-of-Work (PoW) and Proof-of-Stake (PoS).

Proof-of-Work

Proof-of-Work mining uses complex algorithms to solve blocks. Miners use compatible software to generate hashes in hopes of finding the right one. Because the algorithms work at an incredible rate to create these hashes, a high amount of processing power is required. This comprises the “work” component of PoW mining.

The “proof” aspect of the PoW protocol means that miners can’t just be right, they must also be first. Therefore to mine successfully with a PoW protocol, miners must have a high hashrate, which is measured in terms of megahashes, gigahashes, and terahashes per second.

Proof-of-Stake

Proof-of-Stake mining differs dramatically from PoW mining. The goals and methods are the same–both verify blockchain transactions and use algorithms to mine.

However, with the PoS protocol, the blockchain keeps a record of “validators” who maintain a stake in the blockchain’s currency. Validators initiates stakes by freezing their coins in a deposit. Then, the algorithm randomly selects a validator and authorizes them to mine a block.

With the PoS protocol, a miner’s capability is predetermined by his stake. 2% ownership means only 2% of the supply can be mined. Thus miners are rewarded for ownership as opposed to raw computing power. The effect is that PoS mining requires much less computing power relative to one’s stake.

Why to Mine Cryptocurrencies?

Blockchain miners assist the cryptocurrency community by keeping blockchains running smoothly. For their efforts, miners are rewarded in two ways.

First, successful miners receive newly minted coins. The number of coins per block is agreed upon by everyone in the network via consensus. Sometimes, the reward will halve every time a certain amount of blocks are mined.

Second, miners receive the fees paid by participants for sending transactions. This is an important ongoing incentive for miners, especially those that mine coins with limited supplies. The more blocks that are mined, the more processing power is required per block. This results in declining profitability percentages, which transaction fees help offset.

What to Consider When Mining a Coin

There are a number of factors that must be evaluated in order to create truly profitable mining. These components all play an essential role in determining which coins to mine:

Target coin’s current price – miners receive newly minted coins as their reward. A coin’s price will affect how much money they receive. If a coin’s price is $500 per coin, and the protocol rewards two coins, the miner can expect to receive $1,000.

Coin volatility – extremely volatile coins may not hold their value well. A newly mined coin could be worth $500, but if it is extremely volatile, its price might drop to $400 in a moment.

Mining difficulty – difficulty helps determine the hash rate required to mine a block. Miners won’t be able to mine coins with out of reach hash rates.

Block size – block size influences mining time. The longer it takes to mine a coin, the higher the cost will typically be.

Mining competition – the number of miners impacts how likely it is that a given miner will be the first to mine a block. Miners of competitive coins will not always be the first to solve the block, meaning they won’t receive a reward, but they’ll still have mining costs.

What are the mining costs?

Miners need to take these costs into account when mining cryptocurrencies:

Electricity price – the cost of electricity and how many watts are used. This price varies based on location.

Hardware price – the cost of the hardware that mining requires.

Hardware maintenance costs – hardware can overheat and break with extended or improper use. Miners must keep their hardware in good condition and repair broken components.

Accessories – this includes cables, screens, and stands that connect the wiring hardware.

Mining difficulty is a estimation of how difficult it will be to create a hash below a specified target. All valid blocks are required to have a hash that falls within the boundaries of this specific difficulty target. The inbuilt mining difficulty is programmed to change every 2016 blocks on the Bitcoin blockchain. Some chains, like Bitcoin Cash for example, have variable mining difficulties that change based on the amount of throughput transactions being processed on the chain.

Miners determine where to utilize their mining resources by comparing the difficulty of mining on different chains with the profitability of mining on that chain. In other words, chains that are more profitable with lower mining difficulty will inevitably attract miners. Once difficulty is determined, the miner must consider overall profitability.

How Can Miners Calculate Profitability?

Option 1

Miners can use the DARI (Difficulty Adjusted Reward Index) formula to compare rewards for two chains that share a reward system. The formula is as follows:

This is a helpful tool that can help miners choose one coin over another.

Option 2

Miners can also search for mining calculators online. These calculators simply require users to input certain values like hashpower, power consumption, and cost of electricity. The calculators will automatically take into account the coin’s current price and create an array of helpful outputs using the appropriate data.

The calculators require the hashing power measured in hashes per second, the power consumption measured in watts, and the cost per KW/h in dollars. The calculators will automatically output a variety of statistics based upon the coin being mined and the data entered by the miner.

These calculators can be used to determine breakeven prices, profitability ratios, and time-based profits.

Below is an example table for two popular coins, Bitcoin (BTC) and Ethereum (ETH). Note that this is solely an example and does not represent a real mining setup, nor real mining profits. It for comparison’s sake only.